Over-the-counter (
OTC) or off-exchange trading is done directly between two parties, without any supervision of an exchange. It is contrasted with exchange trading, which occurs via exchanges. A stock exchange has the benefit of facilitating liquidity, mitigates all credit risk concerning the default of one party in the transaction, provides transparency, and maintains the current market price. In an OTC trade, the price is not necessarily published for the public.
OTC trading, as well as exchange trading, occurs with commodities, financial instruments (including stocks), and derivatives of such. Products traded on the exchange must be well standardized. This means that exchanged deliverables match a narrow range of quantity, quality, and identity which is defined by the exchange and identical to all transactions of that product. This is necessary for there to be transparency in trading. The OTC market does not have this limitation. They may agree on an unusual quantity, for example.[1] In OTC market contracts are bilateral (i.e. contract between only two parties), each party could have credit risk concerns with respect to the other party. OTC derivative market is significant in some asset classes: interest rate, foreign exchange, stocks, and commodities.[2]
In 2008 approximately 16 percent of all
U.S. stock trades were "off-exchange trading"; by
April 2014 that number increased to about forty percent.[1] Although the notional amount outstanding of OTC derivatives in late
2012 had declined 3.3% over the previous year, the volume of cleared transactions at the end of 2012 totalled US$346.4 trillion.[3]
The Bank for
International Settlements statistics on OTC derivatives markets showed that notional amounts outstanding totalled $693 trillion at the end of June
2013... [T]he gross market value of OTC derivatives – that is, the cost of replacing all outstanding contracts at current market prices – declined between end-2012 and end-June 2013, from $25 trillion to $20 trillion."
OTC derivatives are significant part of the world of global finance. The OTC derivatives markets are large. They grew exponentially from
1980 through
2000. The expansion has been driven by interest rate products, foreign exchange instruments and credit default swaps. The notional outstanding of OTC derivatives markets rose throughout the period and totalled approximately
US$601 trillion at
December 31,
2010.[9]
In their 2000 paper by Schinasi et al. published by the
International Monetary Fund in
2001, the authors observed that the increase in OTC derivatives transactions would have been impossible "without the dramatic advances in information and computer technologies" that occurred from 1980 to 2000.[10] During that time, major internationally active financial institutions significantly increased the share of their earnings from derivatives activities. These institutions manage portfolios of derivatives involving tens of thousand of positions and aggregate global turnover over $1 trillion. At that time prior to the financial crisis of 2008, the OTC market was an informal network of bilateral counterparty relationships and dynamic, time-varying credit exposures whose size and distribution tied to important asset markets.
International financial institutions increasingly nurtured the ability to profit from OTC derivatives activities and financial markets participants benefitted from them. In 2000 the authors acknowledged that the growth in OTC transactions "in many ways made possible, the modernization of commercial and investment banking and the globalization of finance."[10] However, in September, an
IMF team led by Mathieson and Schinasi cautioned that "episodes of turbulence" in the late
1990s "revealed the risks posed to market stability originated in features of OTC derivatives instruments and markets.[11]
The
NYMEX has created a clearing mechanism for a slate of commonly traded OTC energy derivatives which allows counterparties of many bilateral OTC transactions to mutually agree to transfer the trade to ClearPort, the exchange's clearing house, thus eliminating credit and performance risk of the initial OTC transaction counterparts.
https://en.wikipedia.org/wiki/Over-the-counter_(finance)
- published: 07 Aug 2015
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